07 - Elimination of Double Taxation
07 - Elimination of Double Taxation
07 - Elimination of Double Taxation
When the first tax treaties were concluded 100 years ago by the
continental European countries,2 it was logical for two states to distribute
the taxable earnings between themselves by allocating the tax right to
only one state, making these earnings tax exempt in the other. Until
World War II, this was the method unanimously applied by all double
taxation conventions between continental European states.3
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Chapter 7 – Elimination of double taxation
On the other side of the ocean, the United States first announced a credit for
foreign taxes in 1918, as a unilateral measure in favour of US citizens. 7
Both the United States and the United Kingdom initially inserted the tax
credit only in their own tax legislation to compensate their citizens for the
taxes they had paid in other (colonial) countries.
5. Not only were the UK tax rates low in the years before 1914, but foreign-source in-come
was generally taxable, if at all, only on a remittance basis. This changed in 1914, both with respect
to the rates of tax and the basis of taxation (Sec. 5 of the UK Finance Act 1914).
6. The question of double taxation received a full discussion in the context of the Roy-al
Commission on the Income Tax in 1920. Its recommendations drew a sharp distinction
between double income taxation within the British Empire and with foreign countries.
Within the Empire, the Commission concluded that the removal of double taxation was an
urgent necessity, because of the common interest in the well-being of every part of the
Empire and the desire for free circulation of capital within it. The Commission took the
position that these elements were lacking with respect to foreign states and recom-mended
that the only solution was reciprocal arrangements between the United Kingdom and each
foreign state (The Colwyn Commission, Cmd 615 of 11 March 1920).
The United Kingdom did not enter in to any comprehensive double taxation
conventions providing for credit relief, but only concluded a number of limited
agreements. This meant that relief from double income taxation was not a feature of
the UK tax system prior to World War II. See Philip Baker (1998).
7. For a clear description and analysis of this early formative period of US
internation-al tax policy, see Michael J. Graetz and Michael M. O’Hear, “The Original
Intent of US International Taxation”, 46 Duke Law Journal 1021 (1997). They
explained how Tho-mas Sewell Adams introduced the Foreign Tax Credit in 1918 as
compensation for for-eign taxes; this became necessary because the tax rates in both
the United States and other countries were rising steeply in the years of World War I.
8. As explained in 2.5., the League of Nations models still serve as the basis for the
model income tax treaties of the OECD, the United Nations and the United States. See
also Mitchell B. Carroll, “Double Taxation Relief, Discussion of Conventions Drafted
at the International Conference of Experts, 1927 and Other Measures”, 1 Department
of Commerce Trade Information Bulletin 523 (1927).
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7.1. Exemption or credit: history in general
An important step forward for the United States and the United Kingdom
was their bilateral double tax convention of 1945, in which the tax credit
was mentioned as the relief method for avoiding double taxation. UK
domestic legislation was changed in the Finance Act of 1945, which
afterwards became known as the “Credit Code” of rules for computing
foreign tax credit.9
After World War II the credit method gradually became more popular
with some states of the European continent, which adopted it either as a
unilateral method, like Germany, or in their treaties, like the Scandinavian
states and, more recently, France, although many continental European
countries still use the exemption method (unilaterally) as the preferred
way to divide international taxation.
Whether the exemption method is better than the credit method has led to
much discussion over the years. Not only tax experts but also economists
have contributed to this discussion about the preferable neutrality of
international taxation. The difference between “capital import neutrality”
and “capital export neutrality” has already been discussed in 2.2.; the
division between the exemption and the credit method contributes to this
discussion.10
With the exemption method the country of residence leaves the taxing
right solely with the source country, giving that country the responsibility
to tax the source income according to its own tax rules and rates. With the
credit method, the residence country gets a subsidiary tax right which will
have its effect when the source country levies a lower tax than the country
of residence, because then an additional amount of tax needs to be paid on
the worldwide income.11
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Chapter 7 – Elimination of double taxation
Countries using the exemption method reserve this mainly for “active
income” such as business profits (through permanent establishments) and
employment income, while they use the credit method for “passive
income” such as interest, dividends and royalties. This distinction has
been taken over in the official recommendation of the exemption method
in Article 23A of the OECD Model Tax Convention.
Both the tax exemption and the tax credit method can be divided in two
different systems: the “full exemption” and the “exemption with
progression” – “full credit” and “ordinary credit”. These methods have
different results, as will be shown by the following example of two
different cases, I and II.12
– an artiste earns 80,000 at home in State R(esidence) and 20,000 abroad
in State S(ource) = worldwide income of 100,000;
– in State R the tax rates are progressive, namely 35% (average) on an
income of 100,000 (= 35,000) and 30% (average) on an income of
80,000 (= 24,000); and
– in State S the tax rate is either 20% (in case I) or 40% (in case II),
leading to 4,000 or 8,000 source tax
Without any relief for double taxation, the total initial tax burden would
be:
Case I Case II
tax in State R, 35% x 100,000 = 35,000 35,000
+ tax in State S 4,000 8,000
total taxes 39,000 43,000
12. The figures for this explanation have been taken from the official Commentary on
Article 23 of the OECD Model Treaty.
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7.2. Explanation of tax exemption and tax credit
methods
With the “full exemption”, the home country, State R, simply omits the
foreign income from its own taxation and only imposes tax on the
domestic income of 80,000, at 30%:
Case I Case II
tax in State R, 30% x 80,000 = 24,000 24,000
+ tax in State S 4,000 8,000
total taxes 28,000 32,000
tax relief in State R: 35,000 – 24,000 = 11,000 11,000
With the “exemption with progression”, the home country, State R, takes
into account the exempted foreign income when calculating the amount of
tax on the remaining, domestic income. Therefore, domestic income is
taxed at the tax rate for worldwide income, i.e. 35%:
Case I Case II
tax in State R, 35% x 80,000 = 28,000 28,000
+ tax in State S 4,000 8,000
total taxes 32,000 36,000
tax relief in State R: 35,000 – 28,000 = 7,000 7,000
With the “full credit”, the home country, State R, simply allows the
deduction of the foreign-source tax from the tax calculated on worldwide
income:
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Chapter 7 – Elimination of double taxation
Case I Case II
tax in State R, 35% x 100,000 = 35,000 35,000
– full tax credit – 4,000 – 8,000
total tax in State R 31,000 27,000
+ tax in State S 4,000 8,000
total taxes 35,000 35,000
tax relief in State R (full tax credit) = 4,000 8,000
With the “ordinary credit”, the home country, State R, also allows a
deduction of the foreign-source tax from the tax calculated on the
worldwide income, but not more than the proportion of tax that would be
attributable to the income from State S (maximum deduction). This
limitation to the average tax rate is a maximum of 35% x 20,000 = 7,000
in this example and applies in Case II:
Case I Case II
tax in State R, 35% x 100,000 = 35,000 35,000
– ordinary tax credit – 4,000 – 7,000 (max.)
total tax in State R 31,000 28,000
+ tax in State S 4,000 8,000
total taxes 35,000 36,000
tax relief in State R (limited tax credit) = 4,000 7,000 (max.)
– For Case I:
176
7.2. Explanation of tax exemption and tax credit
methods
Of the two exemption methods, the “full exemption” is usually the most
advantageous method for eliminating double taxation for the artiste in this
example. The “full exemption” will be given against the marginal, highest
applicable tax rate, while the “exemption with progression” allows the
exemption against the average tax rate on the income in the country of
residence. This makes a big difference in a country with steep progressive
tax rates.
In any case, in both situations the tax relief can be more than the foreign-
source tax, but can also be lower. This will happen sooner with the
“exemption with progression” method than with the “full exemption”
method, as the examples in 7.2.2. and 7.2.3. and the summary in 7.2.6.
show.
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Chapter 7 – Elimination of double taxation
“full exemption” method, where these foreign losses are included in the
exemption.
From the two tax credit methods, the “full credit” gives the best result for
the taxpayer. The tax relief from this method seems to be closest to the
theory of “capital export neutrality”, because the total tax burden after the
full tax credit is equal to the tax that would be due if the income were
earned in the home country only. At first sight, it is a nicely balanced
credit system, with the same overall tax burden regardless of whether the
income had a domestic or foreign source.
But problems can arise for state budgeters when the foreign-source tax rate is
higher than the tax rate in the country of residence. This was already
recognized in 1921 in the United States, a mere 3 years after the foreign tax
credit was introduced in the Revenue Act. The limitation to “ordinary credit”
was enacted to prevent taxes from countries with income tax higher than that
in the United States from reducing US tax liability on US-source income. The
reason was that the income tax rates in the United Kingdom in those post-war
years were so high that the United States was afraid that all domestic tax
revenue would be wiped out by a full foreign tax credit. The United States
stated the opinion that at least it wanted to collect the taxes that fairly
belonged it.15 This provision still constitutes a fundamental basis of US law
for taxing income earned abroad by US residents.
The United Kingdom also limits the tax credit to a maximum, which is
the amount of UK tax attributable to the income which has been subject
to foreign tax.16 This is the same for other countries using the tax credit
system.
Article 23B of the OECD Model Tax Convention follows the views of
the United States and the United Kingdom and recommends in general
the use of the “ordinary credit” method for countries wanting to apply the
credit system to all types of foreign income, both active and passive. But
the conclusion from the example is that this might lead to insufficient
compensation for the foreign artiste tax, as shown in Case II in 7.2.4.
15. Internal Revenue: Hearings on H.R. 8245 Before the Committee on Finance of the
United States Senate, 67th Congress, 1st Session (1921), reprinted in 95A Internal
Rev-enue Acts of the United States 1909-1950, Legislative Histories, Laws and
Administra-tive Documents (Bernard D. Reams, Jr., ed. 1979).
16. See Philip Baker (1998), at 445.
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7.3. Recommended relief of double taxation under Article 17
In the examples, the taxable income was the same in both the source state
(State S) and the residence state (State R). This is an ideal situation, but
not very realistic for international performing artistes. They very often
need to deduct in their residence country extra business expenses, mainly
indirect and overhead expenses. And, like many others, artistes can have
personal allowances, such as for mortgage interest, alimony, gifts, free
taxable amounts, etc., that further reduce their taxable income in the
country of residence. This has a negative effect on the results of all
methods for the elimination of double taxation.
The 1963 OECD Model Treaty expressed no preference for the method of
elimination of the double taxation that resulted from Article 17. The
income of international artistes was considered “active income”, leading
to the use of the exemption method in bilateral tax treaties by most of the
continental European countries. Other countries, such as the United States
and the United Kingdom, used the credit method for artistes, as they did
for other sources of active income.
With the introduction of Article 17(2) in the 1977 OECD Model Tax
Convention, a new Paragraph 5 was also added to the Commentary on
Article 17, giving a recommendation for the method for eliminating the
double taxation that would result from the article. The OECD advised its
Member countries to use the credit method. This could be problematic in
some countries, because they were not able to apply the credit method to
this type of active income, and for these countries the OECD advised the
introduction of a special, subsidiary tax right for foreign performance
fees. The text of Paragraph 5 of the 1977 Commentary was as follows:
5. Where in the cases dealt with in paragraph 2 the exemption method for
relieving double taxation is used by the State of residence of the person receiving
the income, that State would be precluded from taxing such income even if the
State where the activities were performed could not make use of its right to tax. It
is therefore understood that the credit method should be used in such cases. The
same result could be achieved by stipulating a subsidiary right
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Chapter 7 – Elimination of double taxation
to tax for the State of residence of the person receiving the income, if the State
where the activities are performed cannot make use of the right conferred on it by
paragraphs 1 and 2. Contracting States are free to choose any of these methods in
order to ensure that the income does not escape taxation.
The 1987 OECD Report came with more extensive considerations about
the preferred method for elimination of the double taxation caused by
Article 17. Even after the 1977 recommendation some Member countries
which had issued their papers for the 1987 Report were still unhappy with
the use of the exemption method. The Report came to the following
paragraph IV.D.4:
4. Subsidiary right to tax for the country of residence
99. The provisions of Article 17 could lead to double non-taxation where,
on the one hand, the country of the artiste’s or athlete’s performance cannot
exercise the taxing powers afforded it under the convention (for example,
because under domestic law the income is not taxable or is specifically
exempted) and, on the other hand, the country of residence applies the
exemption method to relieve double taxation. This is seen as a major tax
compliance issue in the countries of residence. The problem is of direct
concern only to those countries of residence which apply the exemption
method to relieving double taxation (either under internal law or under a
convention). The problem arises not only where the income is not taxed at
source; even when income is taxed in the country in which it is earned, the
rate is often considerably lower than that of a progressive scale of taxation
which would be applied by the country of residence. Some countries are very
dissatisfied with this situation and resort to the use of the credit method in
such cases.
100. The Commentary on Article 17 refers to this problem when dealing with
the special case of artiste companies (in paragraph 5 of the text) and suggests
as a solution, that either the credit method be used, or a subsidiary right to
tax for the country of residence should be recognised. That country would be
allowed to tax the income in question when this has not been done in the
country where the performance takes place. The first of these solutions is
also referred to in a more general context in paragraphs 32 and 47 of the
Commentary on Article 23A. In cases where a country is unable to use the
credit method, it should of course adopt the second solution.
101. The Committee’s conclusion on this point is that there is nothing to
prevent two Contracting States from adopting one or other of these two
possible solutions in a bilateral convention. They should endeavour to do so
when there is a high risk of double non-taxation, tax avoidance or evasion.
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7.3. Recommended relief of double taxation under Article 17
The advice to insert a subsidiary right to tax in the tax treaty for the
residence country has found no following in practice. It is unclear why
countries are ignoring this OECD opportunity that could strengthen their
taxing rights regarding artistes. It may be that they do not consider the
double non-taxation of artistes to be a real problem or that they trust that
relying on the tax credit method for relief from double taxation (or even
the exemption method) will be sufficient.17
The recommendation of the tax credit method for Article 17 of the OECD
Model is different from the recommendations for Article 7 (Business
profits) and Article 15 (Income from employment). OECD Member
countries are free to choose between the tax credit and the tax exemption
method for these sources of income.
This change in policy can be seen in the tax treaties that the Netherlands
has concluded over the years. Initially the Netherlands inserted the
exemption method in its tax treaties, following the general, continental
European principle that the elimination of double taxation on “active
income” was best prevented by the exemption method. But in the early
1970s the Netherlands started to change this policy regarding Article 17
and introduced the credit method in some of its new tax treaties. The 1980
tax treaty with the United Kingdom was the last treaty with the exemption
method; subsequently the Netherlands followed the advice of the
Commentary on Article 17 of the OECD Model Tax Convention.18
17. The option for a subsidiary right to tax or for a “subject to tax” clause
was discussed at the 2004 IFA Congress in Vienna, with regard to the
issue of “double non-taxation”.
18. But interestingly enough the Netherlands does not say anything about
this in its official tax treaty policy, Nota “Internationaal fiscaal
(verdrags)beleid”, VN 1998/22.3.
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Chapter 7 – Elimination of double taxation
Below is a list of the tax treaties of the Netherlands and the method of
elimination of double taxation that is used for Article 17, sorted by the
year in which the tax treaty was concluded:
Tax treaties the Netherlands and method of elimination double taxation from
Article 17
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7.3. Recommended relief of double taxation under Article 17
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Chapter 7 – Elimination of double taxation
Interestingly enough there are also countries that have not changed their
national rules for eliminating double taxation and stick with exemption
(with progression) as the proper method, even though their tax treaties
contain the tax credit method. Examples of such countries are Belgium
and Germany. The national tax legislation of these countries does not
contain any measures to apply the tax credit system to active income, but
only to passive income such as dividends, interest and royalties.
The difference in approach between tax credit and tax exemption can
sometimes lead to a rare confrontation in a specific tax treaty between
two countries, each following a different elimination method. An
example is the 1980 Netherlands–United Kingdom tax treaty, granting
UK artistes (and sportsmen) a tax credit for Dutch tax that has been paid
on Dutch performances,19 while allowing Dutch artistes (and sportsmen)
a tax exemption for performance income earned in the United
Kingdom.20 This tax treaty clearly shows the difference between the
traditional continental and Anglo-American methods for eliminating
double taxation.21
184
7.4. Basket/overall method versus per-country
method
With the overall (or basket) method the total of foreign artiste tax is added
up and credited as one amount against the income tax in the residence
country. High and low foreign artiste taxes cancel each other out before
they are tested against the maximum of the (average) tax rate that is
applicable in the residence country.
In a situation with only foreign profits the tax relief is highest when the
overall (or basket) method has been inserted in the legislation of the
residence country. This system evens out the differences in the level of
the foreign-source taxes before applying the limitation test of the
(average) tax rate in the country of residence.
But when the result from one or more source countries is negative, the
per-country method can become more profitable because these losses can
be offset against other, domestic, positive results and already give tax
relief, while foreign tax credit can be used only for foreign profits.22
22. This division between foreign profits and losses can be important for foreign ar-
tistes because their expenses may be very high. See chapter 8 for a survey of these ex-
penses.
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Chapter 7 – Elimination of double taxation
The United States used the per-country method from 1932 until 1954, but
then introduced the overall method as an option. In 1976, the per-country
system was abolished. The overall system was modernized in 1986 and
changed into the so-called basket system. The United States has created
nine categories (or baskets) of income that qualify for foreign tax credit,
such as passive income, financial services income, dividends, shipping
income and a residual category called general limitation income. Artiste
performance income falls in the general limitation income basket, leading
to the result that no division needs be made between the various countries
where performances have taken place, as in a normal overall credit
system.23 US artistes can therefore neutralize (in the same taxable year)
the artiste tax from high-tax countries, such as Germany, Spain, Belgium
and sometimes the United Kingdom, with the artiste tax from low-tax
countries, such as the Netherlands, Denmark and Canada.
Income from royalties from a foreign source falls within the first category
(basket) of passive income and therefore does not have any effect on the
tax credit for foreign performances.
The United Kingdom still uses the per-country method for foreign tax
credits for its artistes.
The Netherlands has changed its system from the per-country method to
the overall method,24 following other European countries, such as
Germany,25 Belgium26 and France.
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7.5. Tax credit
problems
Using the tax credit method is more complicated than the preceding
discussion would suggest. It sounds simple to “apply for a foreign tax
credit”, but various problems can arise, causing practical difficulties.
Without doubt, the tax exemption method is easier to use because the
allocation rule in Article 17 of the tax treaty already gives access to this
compensation in the residence country, regardless of whether any
information about the foreign artiste tax is available or even whether any
tax has been paid in the foreign country.29
But this could also easily lead to double non-taxation if no source tax
were paid in the country of performance. 30 This risk is mentioned in
Paragraph 12 of the 2003 OECD Commentary on Article 17.
29. Several Dutch court cases show that the exemption method gives easier access to
a tax reduction in the source state: Gerechtshof Den Bosch 10 June 2003, VN
2003/56.1.3, Gerechtshof Den Bosch 10 July 2003, NTFR 2003/1488 and Gerechtshof
Den Bosch 5 November 2003, VN 2004/14.1.2.
30. Especially in countries, such as Belgium, that apply the exemption method to for-
eign performance income and can – to some extent – be considered as tax havens for
ar-tistes (and sportsmen).
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Chapter 7 – Elimination of double taxation
contributions,31 but just the taxes that have been specified in Article 2 of
a tax treaty, namely direct taxes on income (and capital).32 This extends
to taxes on the total amount of wages or salaries paid by undertakings,
but social security charges, or any other charges paid where there is a
direct connection between the levy and benefits to be received, are not
regarded as creditable taxes.33 It is not important which authority has
imposed the taxes – the state itself or its political subdivisions or local
authorities. The method of levying is equally immaterial: by direct
assessment, by deduction at source, in the form of surcharges or as an
additional tax.34
The qualification of the artiste tax in the source country can lead to confusion
because many countries levy the tax from the gross performance fee without
the deduction of any expenses. This means that it is not the “income” but the
“earnings” that are taxed, giving the withholding tax the character of a
indirect sales tax or VAT rather than a direct income tax. The question can
arise whether this tax on gross earnings is creditable or whether an exemption
can be allowed, because the source tax might not be a tax on income (and
capital) that is mentioned in Article 2 of a specific tax treaty. 35 An old Dutch
tax court decision of 1958 dealt with this issue, in which the special Swedish
artiste tax for non-resident artistes was considered an indirect sales tax, not
leading to a tax exemption for a Dutch
31. Social security contributions are levied in e.g. France and Germany. Sometimes these
extra levies cannot be avoided, not even with a E-101 (or D-101 from the United States), as
occurs in Germany with the Künstlersozialversicherung (Artistes Social Insurance).
32. See also Michael Lang, “Taxes covered – What is ‘Tax’ according to Art. 2 of the
OECD Model?”, 59 Bulletin for International Fiscal Documentation 6 (2005), at 216.
33. Paragraph 3 of the Commentary on Article 2 of the OECD Model Treaty.
34. Paragraph 2 of the Commentary on Article 2 of the OECD Model Treaty.
35. The issue of artiste tax as Umsatzsteuer (VAT) has also been discussed by Harald
Grams in Besteuerung von beschränkt steuerpflichtigen Künstlern, Neue Wirtschafts
Briefe (Herne/Berlin, 1999), at 35, especially in the European context. Grams
defended the position that gross taxation without the deduction of expenses is a
forbidden VAT for EU countries. See chapter 11 for further discussion.
188
7.5. Tax credit
problems
artiste because it did not fall under the Netherlands–Sweden tax treaty. 36
It is not very likely that this decision would still be followed today. 37
But the preceding will apply to the special VAT that is levied in Ireland
from artistic performances and cannot be considered as Irish income tax.
The foreign tax must also be a final tax and not a prepayment or an
advance withholding tax. When a later settlement, application or tax
return is needed (or possible) to finalize the income tax, this procedure for
getting taxes assessed must be followed, perhaps even leading to a tax
refund. Only the final tax on the tax assessment can be credited in the
residence country.
36. Hoge Raad 5 March 1958, BNB 1958/147. An interesting decision, because a lower
Dutch tax court had decided earlier in 1957 in another case that the Swedish wage tax of an
artiste/employer did fall under the treaty and therefore a tax exemption was possible
(Gerechtshof Den Haag, 29 May 1957, BNB 1957/328). The difference between the two
decisions seems to be that the 1957 case dealt with normal Swedish wage tax and the 1958
case with the special gross taxation for self-employed, non-resident artistes. But the 1957
decision was not brought further to the Dutch Hoge Raad, so we will never know whether
this subtle difference would have been upheld at appeal.
37. But another discussion can be whether the system of gross taxation of non-resident
artistes may be considered within the European Community as a forbidden VAT. See
11.9. for a discussion on this.
38. Treas. Reg. § 1.901-2(e)(5)(i); see also Schering v. Commissioner, 69 T.C. 579
(1978). Source: Kenneth J. Vacovec, Tonya S. James and Les. L. Hoiberg, “The US
For-eign Tax Credit for Corporate Taxpayers”, 55 Bulletin for International Fiscal
Docu-mentation 9/10 (2001), at 397.
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Chapter 7 – Elimination of double taxation
39. This occurred e.g. in the Netherlands in Hoge Raad 9 October 1991, BNB 1991/
324.
40. See Paragraph 8 of the Commentary on Article 17 of the OECD Model Treaty;
see also 2.11. and further in this thesis. The issue was also discussed in depth in Angel
J. Juárez, “Limitations to the Cross-Border Taxation of Artistes and Sportsmen under
the Look-Through Approach in Article 17(1) of the OECD Model Convention”, 43
Europe-an Taxation 11 (2003), at 409.
41. See Sandler (1995), at 196.
42. This issue of (non-)transparency not only happens with artistes, but also with
part-nerships, as explained in Jean Schaffner, “The OECD Report on the Application
of Tax Treaties to Partnerships”, 54 Bulletin for International Fiscal Documentation 5
(2000), at 218.
43. See John Avery Jones et al., “The Interpretation of Tax Treaties with Particular
Ref-erence to Art. 3(2) of the OECD Model”, British Tax Review (1984), at 14 and 90.
190
7.5. Tax credit
problems
the residence country apply Article 3(2) to a term in different ways this
can lead to double taxation.
This problem very often arises with orchestras, theatre groups, musicals
and dance companies, for whom the foreign tax in the country of
performance is withheld and paid in the name of the main artiste, group or
production,44 but the tax credit or exemption in the residence country
needs be granted individually, i.e. on the personal tax declarations of the
performing artistes. This very often leads to the result that a tax credit
cannot be divided between the artistes, 45 is not accepted by the tax
authorities or is just simply forgotten. This a major tax credit or
exemption problem for artistes; very often the foreign artiste tax remains
as an unrecoverable loss in the annual accounts.46
If a third party is involved in the agreement between the artiste and the
organizer of the performance and the three parties are based in different
countries, a tax credit problem can arise for either the artiste or the third
party, or even for both. Particularly with the unlimited approach of Article
17(2), as discussed in chapter 2, the source country is allowed to tax the
full performance fee, regardless of who is entitled to what proportion of
it. The tax authorities of both the country of residence of the artiste and
the third party can be unsure whether the tax treaty with the source state
applies.
This gets even more complicated when the performing artistes of a group
live in different countries.
44. E.g. the non-resident artiste tax rules in the Netherlands were simplified from 1
Jan-uary 2002, after which the tax can be raised from the group instead of the
individual ar-tistes. It is also paid to the tax administration in the name of the group
and there is no requirement to specify the details of the individual performing artistes.
45. See also Jörg Holthaus, “Besteuerung international tätiger nichtselbständiger Be-
rufssportler und Künstler: Ein totgeschwiegenes Problem der Umsetzung der Regelun-
gen der DBA in der Praxis”, Internationales SteuerRecht 18/2002, at 633.
46. This problem was also discussed in Dick Molenaar and Harald Grams, “Rent-A-
Star – The Purpose of Article 17(2) of the OECD Model”, 56 Bulletin for International
Fiscal Documentation 10 (2002), at 500.
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Chapter 7 – Elimination of double taxation
If the non-resident artiste does not receive any information about the tax
that has been paid with respect to his performance fee, he will not be able
to apply for a foreign tax credit in his residence country. This lack of
information leads to juridical and/or economic double taxation. The
exemption method in the country of residence would remove this risk.
47. In the European Union this might lead to unequal treatment and form an
obstruction to entry into other markets within the Union. See also chapter 11.
192
7.5. Tax credit
problems
the tax was actually paid. US artistes (and other taxpayers) are entitled to
choose between these two options,48 making it possible to achieve the
most advantageous outcome and avoid unnecessary excess credits.49
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Chapter 7 – Elimination of double taxation
tax treaties. But some tax treaties granted the source country the right to
withhold a certain percentage of withholding tax on royalties, such as
10% for Japan,53 5%-10% for Italy and 5%-10% for Spain.
Famous Music Corp. did not apply for a foreign tax credit for the
withholding tax, but just deducted this foreign tax before allocating 50%
of the net profit to the composers. These composers started complaining
in 1997 and asked for an equal portion of the foreign tax credit, but
Famous Music refused.54
The New York Court of Appeals agreed with Famous Music, because the
wording of the contract did not allow sharing the foreign tax credit, but
more importantly, “the application of the tax credit was too complex,
even by tax standards”. Foreign-source income needs to be categorized in
“baskets”, which cannot be combined, and excess credits are possible. 55
The court stated that the foreign tax credit is “one of the most intricate
and convoluted features of the entire US tax system”. 56 It decided that
Famous Music Corp. did not have to share any benefit from foreign tax
credits with the composers.
53. This 10% was mentioned in the 1971 Japan–United States tax treaty. The new
2003 tax treaty, which will be effective from 1 January 2005, brings down the
withholding tax to a maximum of 5%.
54. At the same time Famous Music Corp. began to apply for the foreign tax credit
for itself.
55. These excess tax credits can be carried backward (for 2 years) or carried forward
(for 5 years), but this makes the tax credit even more complicated.
56. Kaplan, Federal Taxation of International Transactions (West Publishing, 1988),
at 81; also Graetz, “The David R. Tillinghast Lecture, Taxing International Income:
In-adequate Principles, Outdated Concepts and Unsatisfactory Policies”, 54 Tax Law
Re-view 261 (2001), at 264.
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7.6. Excess tax credits
International artistes very often suffer excess tax credits, caused by high
withholding taxes in the country of performance, the non-deductibility of
production expenses in the source state and other practical difficulties, as
explained in the preceding paragraph. This will be discussed further in
chapter 9.
Tax treaties almost never allow the deduction of source tax as an operating
expense in the residence country. The OECD Model Tax Convention does not
support it and individual bilateral tax treaties have not implemented this
possible option. This is not surprising because it must be seen as a last resort,
compensating only a part of the foreign-source tax. Many countries grant a
right to deduct the foreign tax when no other means has been provided, i.e.
when no tax treaty applies. But some countries give the deduction of foreign-
source tax a stronger status, by offering the option to choose the deduction
method in any situation. E.g., anyone in the United States with unlimited tax
liability on his full worldwide income can choose not to take a tax credit for
foreign tax, but to deduct the foreign tax as a
57. Although there may be limitations to the carry-back and/or carry-forward of the
ex-cess tax credit to other years.
58. § 904(c) of the Internal Revenue Code, 2 years back and 5 years forward.
59. Articles 13 and 14 of the Besluit ter voorkoming van dubbele belasting 2001.
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Chapter 7 – Elimination of double taxation
business expense, so that the tax base will become considerably lower. 60
When normal tax rates are applicable, this will not be profitable, because
the tax effect of this deduction will be lower than the potential tax credit.
But when the foreign (artiste) tax is high or domestic income is low or
negative, the choice of a deduction as an expense might become
advantageous.
Germany also gives its residents with unlimited tax liability the option of
choosing the deduction of the foreign tax from worldwide income as a
business expense.61
The recommendation of the OECD for the tax credit for Article 17 also
deviates from the recommendations for other sources of active income in
the OECD Model (Articles 7 and 12). Countries are free to choose for
these sources whether they want to insert the tax credit or exemption
method in their bilateral tax treaties.
196
7.8. General discussion and
conclusions
Many tax credit problems may occur in practice, arising from the absence
of a tax certificate, the qualification of the foreign tax, the person of the
artiste, the differences in the taxable base and triangular situations to the
complexity of the systems of foreign tax credits in many countries. There
is a major risk that a tax credit in the country of residence may not be
(fully) obtainable.
The tax exemption method would mitigate some of the problems and
would seem to divide the issues of the proper elimination of double
taxation more between the tax administration and the artiste. With the
recommended tax credit method the risks unfortunately lie mainly with
the international performing artistes and not with the tax authorities.
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Chapter 7 – Elimination of double taxation
198